Lou Ranieri on Mortgage

Long Lou Ranieri article on housing market from IDD

Ranieri's take on the current housing situation is pretty bleak, but it is a perspective that may have deeper resonance with investors and deal makers on Wall Street because Ranieri has seen previous real estate debacles, notably the real estate bust of the late 1980s that was felt into the early 1990's.

"When I look at the carnage in the housing market, the mortgage market looks like Berlin after the war," says Ranieri. "It is a pretty big mess. One that, I think, will take a number of years to work our way through."

Some of the problems, he says, are the lax lending standards at the mortgage banking firms, which initially, underwrote subprime or nonconforming mortgages using guidelines similar to those of the conforming loan market -- that is, home loans guaranteed by Freddie Mac and Fannie Mae.

In the early days, recalls Ranieri, "Even when you did a nonconforming loan, you always quoted Fannie Mae doc underwriting [standards] even though it was not [a conforming loan]. You wrote it to their specs and docs, their debt-to-income ratios and documentation. You had a standard for what is a good loan," he says. "When Fannie Mae and Freddie Mac got tied up in the politics of agency or no agency, or whatever, and the Street started to do more and more away from the agencies, one of the things that disappeared was this whole notion of standardization. That was the first series of things to go awry."

As Ranieri sees it, the current housing recession is being exacerbated by the mortgage crisis. "You were going to have a housing recession. What you're getting is a typical housing recession that is compounded by the mortgage crisis," he says. "But they are different. The overbuilding in Phoenix, Florida or Orange County has nothing to do with the mortgage crisis. Putting the two together, you get the hackneyed term of the perfect storm."

Ranieri adds that "the housing recession was not created by the mortgage crisis. It may have augmented it, but it was not created by it." The Root Markets chairman believes that the housing market was due for a correction because affordability for many buyers was "going out of the window."

Indeed, different measures of affordability, including one devised by a realtors' trade group, showed that fewer Americans in 2005 could afford homes amid the rapidly rising prices -- even though mortgage rates were low by historic standards.

Ranieri believes the current crisis differs from that of the early 1990s because the earlier one chiefly involved savings and loans. In that crisis, thrifts went broke, but in this case, families will feel the brunt of the crisis.

"Some people will argue, and to some degree fairly, that the financial technology pushed homeownership deeper into the population...than ever could have been done without it. That's fair. It's true. The trouble was some people took that same technology and in my opinion horribly abused it," says Ranieri.

Asked if the Federal Reserve should have raised rates earlier to temper the rise in home sales and the climb in home prices, Ranieri says "not necessarily. I am not sure that is the case."

Ranieri won't single out any mortgage industry professional for today's problems in housing finance. Instead, the blame falls on a wide range of participants in the mortgage industry, from brokers who underwrite the loans to firms that resell the loans into bonds.

For example, Ranieri notes that in recent years, bonds pooling home loans were created using less subordination -- so less of the monthly principle and interest payments that homeowners pay to bond holders were set aside for possible losses -- even as property prices rose and underwriting standards fell.

"The higher the property values, the more you used to beef it [subordination] up -- not the more you used to thin it," says Ranieri, adding that disclosure of risks in bond deals also has declined.

Global Alpha down > 40% in two years

From the WSJ ($)

For years, Goldman Sachs Group Inc.'s flagship Global Alpha hedge fund could do no wrong. Over the past year, it has been able to do almost nothing right.

August was the worst month in the fund's 12-year history; it was down 22.7% last month alone, according to a recent letter to investors. So far this year through the end of August, it was down 33.4% due to bad bets on everything from the Australian dollar, the Norwegian stock market and Japanese government bonds. The letter gave no indication about how the fund was faring this month. Over the past 12 months, the fund has lost 37% of its value.

That performance is a tough pill for Goldman and the two University of Chicago alumni, Mark Carhart and Ray Iwanowski, who run the fund. The pair had garnered accolades -- and made Goldman the envy of other Wall Street firms -- when Global Alpha was one of the best performing of the hedge funds set up by Wall Street investment banks. Mr. Carhart, an avid cyclist, and Mr. Iwanowski were among Goldman's highest-paid executives in recent years.

This is on top of a 9% decline in 2006 so an investor who entered in 2006 is now down 40%+ and would need the fund to return 70%+ just get to par. Tough slogging for the premier fund of the premier investment bank.

How to lever 100:1

From Nuriel Roubini's blog

Here are two examples of how uncertainty and opacity has vastly increased in financial markets.

First, you take a bunch of shaky and risky subprime mortgages and repackage them into residential mortgage backed securities (RMBS); then you repackage these RMBS in different (equity, mezzanine, senior) tranches of cash CDOs that receive a misleading investment grade rating by the credit rating agencies; then you create synthetic CDOs out of the same underlying RMBS; then you create CDOs of CDOs (or squared CDOs) out of these CDOs; and then you create CDOs of CDOs of CDOs (or cubed CDOs) out of the same murky securities; then you stuff some of these RMBS and CDO tranches into SIV (structured investment vehicles) or into ABCP (Asset Backed Commercial Paper) or into money market funds. Then no wonder that eventually people panic and run - as they did yesterday – on an apparently “safe” money market fund such as Sentinel. That “toxic waste” of unpriceable and uncertain junk and zombie corpses is now emerging in the most unlikely places in the financial markets.

Second example: today any wealthy individual can take $1 million and go to a prime broker and leverage this amount three times; then the resulting $4 million ($1 equity and $3 debt) can be invested in a fund of funds that will in turn leverage these $4 millions three or four times and invest them in a hedge fund; then the hedge fund will take these funds and leverage them three or four times and buy some very junior tranche of a CDO that is itself levered nine or ten times. At the end of this credit chain, the initial $1 million of equity becomes a $100 million investment out of which $99 million is debt (leverage) and only $1 million is equity. So we got an overall leverage ratio of 100 to 1. Then, even a small 1% fall in the price of the final investment (CDO) wipes out the initial capital and creates a chain of margin calls that unravel this debt house of cards. This unraveling of a Minskian Ponzi credit scheme is exactly what is happening right now in financial markets.

So combine an opaque and unregulated global financial system where moderate levels of leverage by individual investors pile up into leverage ratios of 100 plus; and add to this toxic mix investments in the most uncertain, obscure, misrated, mispriced, complex, esoteric credit derivatives (CDOs of CDOs of CDOs and the entire other alphabet of credit instruments) that no investor can properly price; then you have created a financial monster that eventually leads to uncertainty, panic, market seizure, liquidity crunch, credit crunch, systemic risk and economic hard landing. The last two asset and credit bubbles in the US – the S&L real estate bubble and bust of the late 1980s and the tech stock bubble of the late 1990s – ended up in painful recessions. The latest credit and asset bubble was much bigger: housing, mortgages, credit, private equity and LBOs, credit derivatives, corporate re-leveraging. So, the current bust and de-leveraging of the financial system is likely to lead to another painful economic hard landing.

Posts From The Future (an occasional series)

Scientists crack levitation, for goodness sake's. From the Telegraph

Levitation has been elevated from being pure science fiction to science fact, according to a study reported today by physicists.

In earlier work the same team of theoretical physicists showed that invisibility cloaks are feasible.

Now, in another report that sounds like it comes out of the pages of a Harry Potter book, the University of St Andrews team has created an 'incredible levitation effects’ by engineering the force of nature which normally causes objects to stick together.

Professor Ulf Leonhardt and Dr Thomas Philbin, from the University of St Andrews in Scotland, have worked out a way of reversing this pheneomenon, known as the Casimir force, so that it repels instead of attracts.

...

The force is due to neither electrical charge or gravity, for example, but the fluctuations in all-pervasive energy fields in the intervening empty space between the objects and is one reason atoms stick together, also explaining a “dry glue” effect that enables a gecko to walk across a ceiling.

Now, using a special lens of a kind that has already been built, Prof Ulf Leonhardt and Dr Thomas Philbin report in the New Journal of Physics they can engineer the Casimir force to repel, rather than attact.

....

Micro or nano machines could run smoother and with less or no friction at all if one can manipulate the force.” Though it is possible to levitate objects as big as humans, scientists are a long way off developing the technology for such feats, said Dr Philbin.

The practicalities of designing the lens to do this are daunting but not impossible and levitation “could happen over quite a distance”.